Why Small Government Reduces Income Inequality

As President Obama struggles to rejuvenate his flagging second term, he’s returning to a theme that struck a chord in 2009: Income inequality. The top 1 percent of income-earners in the United States bring in 22.3 percent of all pre-tax income, which many feel is inherently unfair. But if Mr. Obama is serious about reining in income inequality, he should promote less government, not more.

The market gives its benefits to the poor more than the wealthy. At the same time, crony capitalism increases the income gap by favoring the rich.

This same trend occurring across a dozen industries, providing marginally more gains to the poor than to the wealthy, helps explain why economic freedom reduces inequality. If we unleash the engine of economic growth, it will primarily benefit the lower-class. The well-connected have always lived in luxury. Capitalism, by enabling cheap mass production, is the first system in history that has brought luxury to the masses. The less governments hobble it, the more it will continue to do so.

Additionally, more economic freedom means more jobs. Those at the top generally have the skills and experience to stay employed no matter what happens, which is why recessions hit the poor hardest. In 2013, the unemployment rate for families making under $20,000 per year was 21 percent. The unemployment rate for those making $150,000 per year was 3.2 percent.

In fact, some scholars have quantified how economic freedom reduces inequality. In “Income Inequality and Economic Freedom in the U.S. States,” Nathan J. Ashby and Russell S. Sobel analyze the 48 continental states of the Union over 20 years and find that more economic freedom shrinks inequality by benefitting the poor. In particular, Ashby and Sobel found that increasing the economic freedom of a state by one unit (equivalent to moving from 40th-freest state to 7th-freest-state) increased the incomes of its poorest residents by 11 percent. By contrast, the same change increased the incomes of the richest quintile by just over a third of that (4.3 percent). As states become more economically free, the economic gap between rich and poor narrows.

The free market undeniably helps the poor. But what many fail to realize is that bigger government benefits the wealthy.

If we’re serious about shrinking income inequality, we need to shrink government. The private sector distributes its gains to rich as well as poor. By contrast, big government, by promoting crony capitalism, just makes the disparity between rich and poor even larger.

Julian Adorney is a Young Voices Advocate and is majoring in English and Advertising at the University of Colorado at Boulder. Julian’s written for the Foundation for Economic Education, the Ludwig von Mises Institute, Junior Scholastic magazine, and Speak Liberty Now.